Profits, land and house builders

There’s a nice piece in the FT today analysing the performance prospects for the housebuilding sector in a period of expected subdued price growth and transaction activity.  It has an interesting take on land market and its effects on how housebuilders might perform.  It also referred to an interesting poll by Reuters of various analysts whose consensus forecast is that house prices “will” rise by 2% next years.  Given the track record of such forecasts, I’d offer good odds that they won’t rise by 2%.

Anyway, getting back to land stuff, Jonathan Eley argues that

…building homes is a margin business and one part of that margin has remained favourable. Land costs normally rise as house prices do. Buying too much land in a rising market during the noughties was a significant reason several builders had near-death experiences in 2008/9. But land prices fell by more than house prices during the crash and have remained subdued ever since. In the year to September, urban land values rose 4 per cent, according to Savills. House prices nationally rose by almost twice that amount. Many of the smaller companies that competed for development land no longer exist. Lower house price inflation, lower transaction volumes and slower economic growth are not good for housebuilders. But the benign conditions in the land market suggest that anyone expecting big declines in profitability in the sector next year is likely to be disappointed.

I’m not really convinced. As has been well-documented, the housebuilders are major land owners themselves.  If land values fall, it isn’t necessarily benign in terms of the value of their main asset base.  Land prices are inextricably linked to house prices.  In a housing slowdown, often all the major costs involved in housing production fall – labour, materials and land.  Cost pressures can be ‘benign’ for worrying reasons.   Nevertheless, the sector does look fairly healthy.  Balance sheets are very healthy, profitability remains high, the balance between supply and demand in the housing market seems to be favourable (if you’re a house builder) and it’s hard to see where a major interest rate shock could come from.  But – “big declines in profitability” and falling land costs should occur if the consensus forecast proves to be too optimistic.

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